India wants to save its forex reserves by allowing trade settlements in rupees

Record lows for the rupee in quick succession over the past few months have evidently ruffled the Reserve Bank of India’s (RBI) feathers. For the first time, the central bank has moved to internationalise the currency.

It rolled out a mechanism yesterday (July 11) for domestic players to settle trade in rupees apart from dollars. This, it said , is aimed at promoting “growth of global trade with emphasis on exports from India and to support the increasing interest of the global trading community in the rupee.”

The move comes after Indian traders faced hiccups in paying overseas clients, especially those in sanctions-hit Russia since the Ukraine war began. It requires foreign entities to set up special vostro bank accounts in their respective countries.

A “vostro account” is one that a bank operates on behalf of another bank — usually from another country — to facilitate wire transfers and other business transactions.

“This step can be particularly useful for neighbouring countries, and those countries willing to use the rupee as a base currency for trade diversification in their settlement rules,” according to Barclays’ economists.

Experts believe these measures have multi-pronged benefits for the Indian economy.

Saving the rupee from its brutal plunge

The Indian currency has lost nearly 7% against the US dollar since the beginning of 2022, marking a series of record lows in recent months. The plunge has been caused by supply chain disruptions amid the Russia-Ukraine war, soaring inflation, and high crude oil prices, among other issues.

Foreign portfolio investors have already pulled out a little over $30 billion from Indian assets this year so far, according to the latest data by National Securities Depository.

“We expect India’s widening current account deficit to remain an ongoing drag for INR, with limited offsets from India’s FDI and overseas investment inflows, exacerbated by ongoing FPI outflows,” Sonal Varma, an economist at Nomura, said in a research note.

The rupee was trading at another all-time low of 79.60 a dollar today.

All this while, the RBI has deployed its sizeable foreign currency reserves to cushion the currency. Evidently, that hasn’t been enough.

Does India have enough forex reserves?

At the end of May, the RBI’s foreign currency reserves stood at $588 billion , significantly down from $633 billion at the beginning of this calendar year.

This move to help settle trade in rupees will help expedite Indian entities’ overseas transactions, thereby reducing the demand for the greenback. However, from a trade standpoint, this route will be restricted to Russia for now, given that India’s other large trade partners may not prefer settling transactions in rupees, experts believe.

In 2021-22, India’s trade with Russia stood at $13.1 billion.

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